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HE101/HE1001
'Lecture 1' 'Economic Concepts' Limited Resources #Limited Budgets #Limited Time #Limited Ability to Produce Microeconomics deals with scarcity. How to make the most of the limits? How to allocate scarce resources? Concept of trade-offs Positive & Normative Statements Positive- Describe cause and effect. Deals with prediction and explanation. Eg: What will be the impact of a tax on...? Normative- What ought to be. Supplemented by value judgment. Eg: Should govt impose...? Markets Collection of buyers and sellers, through actual or potential interaction, determine prices and quantities of products. Types of Markets: Perfectly Competitive (Large no. of buyers, sellers. Firms are price takers), Non-Competitive (Firms can determine prices) Real Vs Nominal Prices Nominal is the absolute or current price of a good/ service. Real is the price relative to an aggregate measure of prices/ constant price. Real Price of Current = Nominal Price of Current/CPI of Current * CPI of Base Yr Aggregate measure of price: Consumer Price Index (CPI) #Records prices of a large basket of goods consumed by a typical consumer #Assign 100 as the index for the base year #% Changes in CPI measures inflation rate Laspeyres Price Index (Use Base Yr Quantities as weights) Calculating CPI Example: 1999, a typical consumer buy 5 books @ $20 each and 30 burgers @ $1 each. 2000, he buys 8 books @ $22 each and 36 burgers @ $1.50 each. Total Value in 1999: $130 (Base Yr Prices and Quantities) Assume 1999 is base year. CPI for 1999 is 100. Total Value in 2000: $155''' (!! Using Base Yr Quantities, but 2000 prices)' CPI for 2000: 100/130 * 155 = 119 Inflation Rate: 19% Laspeyres Price Index assumes consumers do not change consumption patterns as prices change. It tends to overstate true cost of living. '''Paasche Index ( Use Current Yr quantities as weights)' Total Value in 1999: $196 ( 2000 Quantities, Base Yr Prices) CPI for 1999: 100 Total Value in 2000: $230 ( 2000 Quantities, 2000 Prices) CPI for 2000: 196/100 * 230 = 117 Inflation Rate: 17% Demand Demand Curve: Downwards Sloping Demand #Substitution Effect- Price rises, subs are relatively cheaper, buy more subs, Qty dd falls #Income Effect- Price rises, purchasing power falls, Qty dd falls. Interpreting Demand Curve: #Prices on Demand Curve are reservation prices @ each qty dd level #Reservation Price = Benefit received from good = MR #Market Price = Cost of Good = MC #Consumers buy until MR=MC Horizontal Interpretation: Price determines qty dd Vertical Interpretation: Qty dd determines reservation price Shifts in Demand Curve: Income, Changes in preferences, Price of Subs/Complements Movements along Demand Curve: Price of Good changes Market Demand Curve: Horizontal summation of all individuals' demand curves. Horizontal summation summing all qty dd at the same price. Supply Assumes constant input prices, tech. Upward Sloping: Firms increase output at higher price levels Horizontal Interpretation: For each price, shows quantity produced Vertical Interpretation: Marginal Cost/ Reservation Price for producing each additional unit Market Supply: Horizontal Summation of individual Supply curves Shifts in Supply: Wages, Input Prices, Technology, No. of Suppliers, Price Expectations, Taxes Lecture 2 Market Mechanisms Tendency in a free market for price to change until market clears. Market clears when qty ss=qty dd. Price at this equilibrium is the market-clearing price. Elasticity Measures how much a variable will change with a change in another variable. Demand is more price elastic in the long run. However, for durables, demand is more price elastic in short run. Consumers will choose to hold on to them when price increases in short run. In long run, durables will have to be replaced regardless of price changes. PED: % Change in Quantity Demanded/ % Change in Price A negative number. <-1, Price Elastic. >-1, Price Inelastic PED depends on no. of substitutes YED: % Change in Qty DD/ % Change in Income XED: % Change in Qty DD of A/ % Change in Price of B +ve if substitutes, -ve if complements PES: % Change in Qty SS/ % Change in Price Point Vs Arc Elasticity Arc Elasticity is based on average price and quantity. Point is more sensitive.